On the measurement of corporate governance and its impact on bank profitability and credit risk: The case of Tunisian listed banks

Abstract This paper explores the influence of corporate governance on the profitability and credit risk of a sample of listed banks in Tunisia. The methodology involves two main steps. Firstly, principal component analysis is employed to construct a novel governance index, assessing the quality of both internal and external bank governance. This index takes into account the degree of compliance and application of directives and laws mandated by the Tunisian Central Bank regarding banking governance. In the second step, panel data analysis is conducted to scrutinize the impact of internal and external governance mechanisms on the profitability and risk of Tunisian banks. The results reveal that as the governance index increases, the profitability of banks improves in terms of return on assets and stock market performance. Additionally, a higher governance index is correlated with a reduction in credit risks, as indicated by lower instances of non‐performing loans and an increased rate of coverage for classified debts. To enhance the robustness of our results, we calculate a standard governance score based on existing empirical literature. Furthermore, to account for potential endogeneity, we employ the two‐step system generalized method of moments.